Recently I interviewed the CEO of City Office (CIO), Jamie Farrar.
In this 15 minute interview we discussed a number of topics ranging from the 18-hour business model, to CIO’s investment model, to future growth prospects. I also touched on CIO’s internalization which is an important part of the overall investment thesis.
I hope you enjoy the video!
PS: We have future interviews scheduled with Boston Properties (BXP), Innovative Industrial (IIPR), Global Medical (GMRE), NetStreit (NTST), and many others.
Thank you for the opportunity to be of service.
Transcript:
Brad Thomas:
Hi everyone. This is Brad Thomas with The Ground Up, and I’m back again with another CEO round table interview. Today I’m joined with Jamie Farrar. Jamie is the CEO of City Office REIT, and the ticker symbol is CIO. Jamie, it’s good to see you today.
Jamie Farrar:
Good to see you too, Brad. Thanks for having me.
Brad Thomas:
You bet. Well of course you’re in the office, which is no surprise, the CEO of City Office. Jamie, you’ve got a really unique business model, at least within our coverage spectrum in the office sector. You call your business model the 18-hour city landlord, I guess. Can you explain exactly what is an 18-hour city?
Jamie Farrar:
Going back over time when we launched this business brand, what we saw was great cities that weren’t 24-hour cities like New York and San Francisco, Los Angeles, but kind of the next tier down, where it’s a live, work, play environment. People are out active 18 hours a day. There’s a downtown core that’s vibrant. Places that are really high growth.
The model we built was, let’s invest in kind of the 50 to a 100 million per building size within the cities. Hydro cities get great locations. Places that we’ve seen huge increases in population and employment, high quality of life. So think in Florida, Tampa or Orlando, Dallas, Denver, Phoenix, San Diego, and really built our business around kind of the next tier down, where we see much better valuations.
Brad Thomas:
Great. And a lot of those cities that you mentioned, I mean, Dallas, Denver, Phoenix, Orlando, Tampa, a lot of those are cities that are certainly in vogue right now, given the pandemic. And we cover the entire office sector, so New York City, San Francisco, some of these urban markets that are under a tremendous amount of stress. So what are you seeing and what have you seen develop in 2020 and now 2021, in terms of customers that are companies that are moving to these markets that you are investing in.
Jamie Farrar:
So initially, I mean, the shock that we felt was the same as every other market, right? Everybody just basically went home, stopped going to the office. We had to reconfigure our own model to make sure that we could get through the pandemic in a strong way, which we did.
But basically stepping back, what happened after kind of a year ago right now, people started to relocate to a lot of the cities, and whether they may still be based in New York, Boston, San Francisco, they started heading the much nicer places and those places, as far as business today, restaurants are busy. People are outside. They’re very active. And so we’ve seen a huge flood of people temporarily coming into our cities and companies kind of rethinking where they want to be long-term. And when you look at the affordability of the places where we invest, there’s a lot of reasons why they should thrive.
And so what we’ve seen as far as leasing, picking up across our markets, it’s starting, we’re starting to get a lot more tours. I’d say at the end of last year, it was still slow, but getting into January, February, we’ve seen a lot more interest in moving to our cities, touring our buildings. And I think that’s a big difference from a lot of the bigger cities, gateway cities, New York. I’m a big believer in New York is going to be fine long-term.
I think there’s going to be a lot of pain short term, particularly when you think about the number of people who are living there that have to pay high state tax, city taxes. They can move to a much more favorable environment, save money. And I think we’re really well positioned to benefit from that over time.
Brad Thomas:
Great. Well listen, I want to dig in with you could Jamie, into your fourth quarter and also 2020 results. Obviously there was, I think no REIT was immune from this pandemic. But how do you feel about, kind of 2020 now that that’s in the rear view mirror? Kind of, can you reflect on some of those highlights, I guess for the year, last year?
Jamie Farrar:
So surprisingly enough, last year we did the most leasing we’ve ever done in the history of our company. And I guess what we’re seeing, if you were to talk about people even today, some of the media reports you see of tenants are not going back to the office, they’re happy working at home. We’re hearing a very different message from a lot of our leasing teams. And so tenants typically will hire their own leasing brokers who are going to go out and look for the best space for them.
And the message they’re getting from a lot of their clients is, it’s not vogue today to be telling employees they’re going back to the office, but that’s exactly what leadership wants. And so there’s going to be cases where people are going to work from home. There’s going to be more, part-time working from home. But generally the message we’re seeing is, companies want their employees back together for all the magic that happens.
Supervisory being able to collaborate, mentoring, younger employees, all these things are huge for a company’s culture. And so we’re seeing that kind of roll forward. For us last year, it was a tough year initially, when all of a sudden everything froze. The phone started ringing where every tenant basically didn’t want to pay rent or were asking, “Hey, are you prepared to not receive rent?”
We had to really adapt to that and we’ve had great results. We’ve had 99% of our tenants pay rent in 2020. We’ve had a few small little companies that didn’t make it, but 99% survived the pandemic and are doing well. We’ve had a big pickup in the number of people who are coming back to the office. That’s starting to accelerate. I think as vaccines continue to roll out, we’re going to see that pickup even more.
So the narrative and theme of the office is dead, is not what we’re seeing. We’re feeling very good about that. And so getting into 2020, we had very high collections. We got a lot of bigger leases done. I think in the system, there’s been a lot of companies kind of kicking the can, trying to do short-term extensions and keep their options open and figure out what they’re going to do.
And so as a company, what we’ve tried to do is take our vacancy that we have, invest in and create great spec suites, kind of similar to, you can see the background, what we have here, great space that it’s move in ready. And so as tenants are coming back and deciding where they want to be long-term, they’ve got great options that we can give to them quickly. And it works well for us as well.
So we’re seeing a good year last year, the last two quarters we’ve had dividend coverage. We did right-size our dividend, about a year ago, as part of our pandemic plan. We lowered our overall leverage. We drew down a whole bunch of cash from our lines so we knew we could make it through the pandemic, which we did.
And so we also decided to buy back some of our stock at low prices as well. So we took a number of steps Brad, to really optimally position ourselves. It’s been a tough year, but results are starting to show that all the steps we’ve made are paying off.
Brad Thomas:
Great. Well, I think you’ve got occupancy, I think last reported about 90%. I know traditionally, I’ve looked at City Office kind of through the lens of this value add. I know you’ve bought some buildings with lower occupancy and historically have ramped that occupancy up to create the value. So at 90%, do you see some upside there, within the portfolio, to increase occupancy from the internal growth engines?
Jamie Farrar:
Yeah, so that’s a huge driver of bottom line cash flow for us because we’re already paying virtually all of our expenses. So when you look at our portfolio stabilized, we think 93, 94 is where we’ve been in the past. That sort of level. It is absolutely achievable as we’re coming back into a bit better releasing market.
Brad Thomas:
Great. Now, in terms of 2021, I won’t talk about the external growth, but can you first touch on the balance sheet and kind of, what type of capacity do you have to expand currently in 2021? Now I know you cut the dividend about a third in 2020, due to the pandemic. So you’ve got a little bit of cashflow there, obviously from 94 cents to 60 cents. How are you capitalized to grow externally going forward?
Jamie Farrar:
We’re in great shape right now. So we have a number of our properties are unencumbered. We have a $250 million available line of credit that we’ve drawn. I’d have to take a look, I think we’re around 75 million draws. So we’ve got significant dry powder and we’ve intentionally kept that on the side as we’re coming back into more of an acquisition environment.
What I’ve been seeing, is kind of counter-intuitive, to be honest, is the cap rates on transactions that have been happening in the market are very low. Meaning, valuations are extremely high right now. And what’s happened is, the number of properties that are being brought to market have been pretty far and few. And so what’s coming is typically very safe, stable long-term leases and valuations are at, kind of pre pandemic levels for those assets.
And so what I think we’re going to see now, the bank financing market starting to improve, and that’s a key aspect of buying buildings. And as that continues to kind of move down the spectrum to some assets that maybe have a little more heavy lifting, a little more value to add. That will open up that market. And I think later in the year, you’re going to see a lot more transactions coming back to market.
And so in our own internal guidance, we’ve circled kind of a hundred million of acquisitions this year. In our low case, we put zero on the assumption, things are really slow. On the high case, a hundred, but we put it at the very end of the year. So there isn’t a lot of income from those acquisitions baked into our numbers. And we think that’s a conservative way to look at it. We do have a number of deals we’re looking at right now and opportunities, but we’re being really cautious.
One of the big shifts for us, is when we look to buy real estate, we go through every inch of the building many, many, many times, and we look and see who’s using the space. Do they have room to grow? Are they in too much space? And in future when their lease has come up, we use all that information to the model what we think is going to happen to that cashflow. It’s expensive when tenants move out.
And so we really try to dial in and understand that. Today, when 20% of the building is being utilized, it’s really hard to underwrite an asset accurately. And so you can value it at a cheaper valuation to account for that risk, or it’s better to hold back a little bit and see and make sure you understand what you’re buying, and that’s what we’ve been doing. And so I think later in the year, we’re going to see much better opportunities.
Brad Thomas:
Right. And then in terms of your geographic footprint, do you anticipate expanding into other markets? I know you’ve got a pretty nice base in the Southeast, but I did see some markets that aren’t, that you’re not in. For example, I don’t think you’re in Charlotte yet. For example, Atlanta, Raleigh, Durham. I’m just curious, are you going to look to expand the footprint or just maintain the current footprint?
Jamie Farrar:
We’ve slowly expanded over the last seven years and the cities you’ve mentioned are all ones we continue to look at. Nashville’s another one that we love. Austin. We’ve had experience in, kind of prior lives in Austin. We love the fundamentals of Austin. It’s very expensive. So it’s all about finding the right opportunity, but we do intend over time to intelligently expand. And typically we’ll buy a building or two initially, get into the market, and then slowly build up on top of that, where we start getting economies of scale.
Brad Thomas:
Great. Last question I want to ask you, as I recall, you internalize the company at, what I would say is, in early innings, I think it was around 300 or 400 million. I may be wrong. So you correct me if I’m inaccurate, but I know you’ve internalized the company. Can you talk a little bit about your decision to internalize, because I know that’s important for me and I think a lot of investors, is to have an internal management platform?
Jamie Farrar:
I guess when we went public, we were very small and we didn’t need an external contract, to kind of put parameters around what administration and GNA would be costs. And we tried to structure it in a way that was very transparent, very friendly for shareholders. And ultimately, as we went up to the investor community, the amount of pushback we got from larger investors was far greater than we ever expected.
And so we went public about, 20% of our stock was held by institutions, 80% by retail. And valuation wise, that started to put a cap box. And so the more meetings we had after that, the more feedback we had, “Look, we love your strategy. We will not buy an external managed company because of the bad history with them.”
And so we made a decision, like you said Brad, to accelerate that. We internalized, I think it was in less than three years, at a much smaller number. And what’s happened from that is, we’ve switched from 80% retail to 80% institutional. Now is that a great thing? There’s pros and cons, but there was much more appetite from larger investors who, I think, translate to a higher multiple of what we can get on our stock. So it made sense to do it
Brad Thomas:
Right. Well closing thoughts there, I think you can have your cake and eat it too on the institutional and the retail side. And one way to do that of course, is to pay monthly dividends. And one of your, I guess, indirect peer staff who also invest in secondary markets and industrial, they do a great job at paying monthly dividends.
So maybe that’s something for you and your board to think about in the future. But at any rate, I want to thank you for your time today and I’m glad to see that recovery is well underway for City Office. We’re going to probably circle back in, to speak with you again after the first quarter results. So look forward to seeing you then.
Jamie Farrar:
Our pleasure. Thanks very much, Brad, have a great day.
Brad Thomas:
Thank you very much. Bye-bye.
Happy Investing
Brad Thomas is Senior Research Analyst at iREIT and CEO of Wide Moat Research LLC. With over 30 years of real estate experience, he is also long-time Editor of Forbes Real Estate Investor, a monthly subscription-based newsletter that dives deep into the vast world of profitable properties, and since 2021, he has served as an adjunct professor at New York University.
Thomas has also been featured on or in Forbes magazine, Kiplinger's, U.S. News and World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. And he was the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, 2019, 2020 and 2021 based on both page views and number of followers.
Thomas is the recently-published author of The Intelligent REIT Investor Guide (2021), co-author of The Intelligent REIT Investor (2016), and he wrote The Trump Factor: Unlocking The Secrets Behind The Trump Empire (2016) - all available on Amazon.
Thomas received a bachelor of science in business/economics from Presbyterian College and is married with five wonderful kids.
